Be wary of supply/demand battle in bonds
The move by the Reserve Bank of Australia to a policy of fiscal stimulus away from monetary policy could cause a supply/demand battle and increased volatility as the central bank battles to support the economy amid COVID-19, Ardea believes.
This is the first major move away from traditional monetary policy in years, especially as Australia managed to avoid the need for quantitative easing during the Global Financial Crisis.
In March, the RBA announced a stimulus package of cutting rates to 0.25% and purchasing Australian government bonds across the yield curve to help achieve a yield target on three-year Australian government bonds of 0.25%. This would then help lower funding costs across the economy.
Gopi Karunakaran, portfolio manager at Ardea, said: “For the past decade monetary policy has been the dominant policy of central banks and now there’s a big shift towards fiscal policy and all this needs to be funded by the governments issuing government bonds. But this is not a good combination if bond yields are at record lows and we will see a big demand/supply battle”.
He said it created a scenario where bond markets would be unable to absorb the vast amounts of incoming government bond supply and, simultaneously, there were fewer pension pools to absorb the bonds as retirees began drawing down their retirement savings.
“Do bond yields go up or prices go down as there is too much to absorb or will central banks be able to hoover all the money? We can expect to see a lot of volatility,” he said.
This created a ‘three-way showdown’ between governments putting more bonds into the market, private investors demanding a higher risk premia to keep buying them and central banks who had to be a buyer of last resort to prevent a violent re-pricing.
In the US, the Federal Reserve, which had already used quantitative easing for many years, said it would extend its bond-purchase program to buy corporate and high yield bonds as well as government bonds, but the RBA said it would only be buying government ones.
“The RBA is not going into credit, they are only buying government bonds so the recovery in the credit space has been slower. We will have to wait and see if the measures are enough,” Karunakaran said
The Ardea Diversified Bond fund returned 8.6% over one year to 30 April, 2020, versus returns of 3.4% by the global bond sector, within the Australian Core Strategies universe, according to FE Analytics.
Performance of Ardea Diversified Bond fund versus global bond sector over one year to 30 April, 2020
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Laura Dew
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